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Inventory Management

Keeping an accurate and adequate control of your inventory is crucial for a successful business operation. Every business must maintain some level of supplies for running an office, restaurant, or manufacturing facility. Here are the key items to consider and how to go about keeping yourself afloat without strapping your cash flow.

Vendor Issues

The people you buy your goods and services from are your vendors. They are critical to the operation of your business. You must have a good understanding of their terms and lead times before you can begin purchasing inventory. Terms are the agreements you have for how long you have to pay your bills ie NET 30 means 30 days after the invoice is created, while NET Cash means you must pay upon receipt of your goods. Another term you will see if FOB, ie freight on board. FOB plant means you pay shipping. FOB destination means the plant pays shipping. You must understand these up front as you will need to understand your total costs involved and how to manage your cash flow. The lead times a vendor offers also effects your inventory settings. You must know the time it will take for things to arrive. You may also want multiple vendors for the same items in case one cannot fulfill your needs at a given time. This is called having back up sources.

Setting Minimums and Maximums

The best way to control your inventory is by setting par levels for each item you use to run your business. Things to consider are lead times to get things, how long your clients are willing to wait for items, sales cycles to sell things, price breaks, and how much cash you have to maintain adequate stock. Ideally to set a minimum amount you must determine the point where you will run out of stock before the next shipment could expect to arrive. The maximum is the most acceptable level and price point allowing you to maximize your profit without tying up your accounts payable. A common term for this cycle of buying and selling inventory is called turns, ie selling out an incoming shipment. Ideally, you would like to turn your inventory several times a year. Setting adequate minimums and maximums allow you to do this. Initially, guesswork is the only way you can do this. As you grow your business, you will begin to see patterns for sales allowing you to be more exact.

Subassemblies for Finished Goods

Every product that is eventually sold has smaller parts that make up the whole. Maintaining adequate stock of subassemblies is critical to maintaining stock of finished goods. For example, a pizza shop may have dough, sauce, cheese, and toppings to stock in order to make a pizza. The shop owner must maintain fresh supplies of everything in order to make a good product. The owner also does not want to throw away rotten food that is not sold. So he must know how many pizzas he sells a week, what types are popular and how long certain items will stay good, so he does not buy more than he can sell. The term for items that do not turn more than once a year or never is dead inventory. Dead inventory not only ties up space, but cash flow as well. The shop also has to stock boxes and napkins, plates, cash register paper, etc. As you can see, there is more than just the final product to consider. Everything that goes into running your business and making the end products must have minimums and maximums.

Finished goods

In a manufacturing or distribution business, the end product ready for sale is called finished goods. Depending on the nature of your business, you must maintain some level of inventory to maintain sales. For example, a fast food restaurant may have several burgers and fries already made at all times, while a pizza shop may have only ready ingredients on hand and make everything to order. Both have to understand the time a client is willing to wait for the product. The fast food burger restaurant may have only 5 minutes before the kids get antsy waiting for their chicken nuggets, while the pizza store can make a client wait 45 minutes for delivery. Conversely, a manufacturing facility can have lead times up to 8-10 weeks. I am sure many of you have experienced this ordering furniture. So ideally, you must know how long is an acceptable lead time for the product or service you are providing and set your finished good minimums and maximums accordingly.

New products also effect your inventory. As you develop other items to market, you will have a more complex set of items to stock and manage. The pizza shop may expand into sandwiches and pasta dishes. Now they have to stock rolls, pasta, aluminum containers for take out etc. As you decide to grow your business offerings, you must look at all the implications on extra inventory can have on your cash flow to maintain stock

Cash flow issues

You must understand how having stock effects your cash flow. Vendor and client payment terms sales cycles and turns effect this dramatically. If your vendors give you 30 days to pay your bills and your clients pay cash on order, you can afford to maintain more stock. If your vendors want cash on order and your clients are paying you in 30 days or more you may need a reserve of cash or a line of credit to maintain stock. Every business has different terms depending on the nature of the sale. You must understand how these payment terms effect your cash and buy inventory with this in mind. You do not want to tie up too much cash in your inventory or you could run out.

Space issues

Another key aspect of maintaining inventory is how much physical space it takes up. Your office/facility only has a finite amount of space. Buying a great deal on a truckload of goods is nice if you can turn it over quickly, however, you may not have anywhere to put it. Dead inventory also takes up space you could be using for your more active items. You must periodically track inventory and sales and either have fire sales to get rid of dead inventory or just throw it out and write it off. Another option is off site storage. You may want to contact companies for a fee who will store your inventory for your offsite. They may even do order fulfillment for you as well. This will free up space in your existing facility to run your operation.

Systems to Track Inventory

The key to understanding how much you have is to have a way to accurately count your inventory. It can be as simple as hand counting the boxes or items on the shelf to using bar coded scanners and computerized systems to maintain your levels. As your business grows, you will need to identify the level of sophistication necessary to maintain an accurate count. Ideally at least once a year a physical verification is needed for tax purposes. If you are small you could do this in a couple of hours. Large manufacturing facilities may have to shut down for 2-3 days and get all employees to do a count.. Things to consider over the year are shrinkage or waste in your manufacturing cycle, theft by employees or clients, bookkeeping errors, and tracking returns for credit.

Other Issues

There are ways to help alleviate your inventory issues. You must try to find ways to simplify your business. One way is identify your regular clients and understand their continuing needs. Clients who order the same thing over a similar period of time can be put on a standing order. This is a situation where X amount of goods are shipped out on a regular basis as monthly, weekly, etc.. By doing this, you can establish an accurate par level for an item and maintain a high level of service for your client. This also takes the guesswork out of when and what they will order from you.

Backorders are also an issue that can arise when you get orders, but have run out of stock. In some cases they are acceptable. For instance, you may have gone to a restaurant and they ran out of the special of the day. Other cases are not so forgiving, such as being the sole source for a hospital and backordering an item for performing an emergency surgical procedure. You must understand the client's needs and forecast appropriately. There are many variables in the inventory management process. There is no definite system that is foolproof. You must find a happy medium so that you can run your business at a maximum profit.